Apple 2005 Annual Report Download - page 78

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 2—Financial Instruments (Continued)
period as the related sales are recognized, and other comprehensive income related to inventory purchases is recognized as a component of cost
of sales in the same period as the related costs are recognized. Typically, the Company hedges portions of its forecasted foreign currency
exposure associated with revenues and inventory purchases over a time horizon of 3 to 6 months.
Derivative instruments designated as cash flow hedges must be de-designated as hedges when it is probable that the forecasted hedged
transaction will not occur in the initially identified time period or within a subsequent 2 month time period. Deferred gains and losses in other
comprehensive income associated with such derivative instruments are immediately reclassified into earnings in other income and expense.
Any subsequent changes in fair value of such derivative instruments are also reflected in current earnings unless they are re-designated as
hedges of other transactions. The Company recognized net losses of $1.6 million and $2.8 million in 2005 and 2004, respectively, in other
income and expense related to the loss of hedge designation on discontinued cash flow hedges due to changes in the Company’s forecast of
future net sales and cost of sales and due to prevailing market conditions. No net gains, or losses, of a similar nature were recorded in 2003. As
of September 24, 2005, the Company had a net deferred gain associated with cash flow hedges of approximately $3.6 million, net of taxes,
substantially all of which is expected to be reclassified to earnings by the end of the second quarter of fiscal 2006.
The net gain or loss on the effective portion of a derivative instrument designated as a net investment hedge is included in the cumulative
translation adjustment account of accumulated other comprehensive income within shareholders’ equity. As of September 24, 2005 and
September 25, 2004, the Company had a net gain of $673,000 and a net loss of $1.8 million, respectively, included in the cumulative
translation adjustment.
The Company may also enter into foreign currency forward and option contracts to offset the foreign exchange gains and losses generated by
the re-measurement of certain assets and liabilities recorded in non-functional currencies. Changes in the fair value of these derivatives are
recognized in current earnings in other income and expense as offsets to the changes in the fair value of the related assets or liabilities. Due to
currency market movements, changes in option time value can lead to increased volatility in other income and expense.
Interest Rate Risk Management
From time to time, the Company historically entered into interest rate derivative transactions with financial institutions in order to better match
the Company’s floating-rate interest income on its cash equivalents and short-term investments with its fixed-rate interest expense on any
outstanding long-term debt, and/or to diversify a portion of the Company’s exposure away from fluctuations in short-term U.S. interest rates.
During 2001 and 2002, the Company entered into and then subsequently terminated various interest rate debt swap agreements generating a
realized gain of $23 million. These gains were deferred and amortized over the remaining life of the underlying debt, which matured and was
repaid in February 2004.
As of September 24, 2005 and September 25, 2004, the Company had no interest rate derivatives outstanding.
76